Inflation Remains Benign; Producer Prices Fall In December

On a day when the investment community received data showing that retail sales advanced 0.5% sequentially (4.7% from the year-earlier figure) in December, we also learned that producer (wholesale) prices for the same month declined modestly. Specifically, the Department of Labor reported that the Producer Price Index for finished goods fell 0.2%. The primary reasons were a 4.8% drop in the index for beef and veal and a 1.7% decline in gasoline prices.

A closer examination shows that the decrease in finished goods prices was led by the index for finished consumer foods, which fell 0.9%. It marked the first decline for the consumer foods component since a 0.4% decrease last May. Prices for energy goods fell 0.3%, the third consecutive monthly decline. Meanwhile, the index for finished goods less these two aforementioned volatile components advanced a rather tame 0.1%. Overall, prices for finished goods advanced 1.3% for the 12 months ended December, 2012, compared with a 4.7% advance in 2011.

The latest report is both a good and bad snapshot of current economic conditions. On the negative side, the data suggest that economic growth in this country is proceeding at a pedestrian pace right now, which is not surprising given the recent data on employment and manufacturing activity. Conversely, the retreat in prices suggests that inflation is not a big issue for the central bank at this moment and is more evidence why Fed Chairman Ben Bernanke has not put the brakes on the central bank’s aggressive bond-buying program. The lead bank remains committed to monthly purchases of $45 billion in Treasuries, in an effort to keep the economy on a growth path.

The benign inflationary environment—the rate of inflation is still in the Federal Reserve’s desired rate of 2% or below—also allows the Federal Reserve to keep interest rates at record lows. It’s more ammunition for the Fed to keep its current accommodative monetary policies in place, with its main focus on making a notable dent in the nation’s stubbornly high unemployment rate, which currently stands at 7.8%. Our sense is that the low interest-rate environment may be in place until at least the early stages of 2015, if the lead bank’s intermediate-term goal is to reduce the unemployment rate to around 6.5%.

All in all, the latest wholesale pricing data reinforces the Federal Reserve’s desire to keep its accommodative monetary policies in place. Investors should note that we will receive the Labor Department’s companion report on consumer prices at 8:30 AM (EST) tomorrow.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.